FINANCIAL STATEMENTS
Financial statements are the means by which the information accumulated and
processed in financial accounting is periodically communicated to the users.
In other words, the financial statements are the end product or main output of the
financial accounting process.
Financial statements are a structured financial representation of the financial position
and financial performance of an entity.
"General Purpose" financial statements?
"General purpose" financial statements are statements that have been prepared for use
by those who are not in a position to require an entity to prepare reports tailored to their
particular information needs.
Reports prepared at the request of an entity's management or bankers are not general-
purpose financial statements because they are prepared specifically to meet the needs
of management or bankers.
Enumerate the complete set of financial statements.
A complete set of financial statements comprises:
1. Statement of financial position
2. Income statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Notes, comprising a summary of significant accounting policies and other
explanatory information
Objective of financial statements.
The objective of financial statements is to provide information about the financial
position, financial performance and cash flows of an entity that is useful to a wide range
of users in making economic decisions.
Financial statements also show the results of the management stewardship of the
resources entrusted to it.
To meet this objective, financial statements provide information about the following:
a. Assets
b. Liabilities
c. Equity
d. Income and expenses, including gains and losses
e. Contributions by and distributions to owners in their capacity as owners
f. Cash flows
Responsibility for financial statements.
The management of an entity has the primary responsibility for the preparation and
presentation of the financial statements of the entity.
The Board of Directors in discharging its responsibilities reviews and approves the financial
statements before these are submitted to the shareholders of the entity.
Accountability of management.
Management is accountable for the safekeeping of the entity's resources and for their
proper, efficient and profitable use.
Shareholders are interested in information that helps them to assess how effectively
management has fulfilled this role as this is relevant to the decisions concerning their
investment and the reappointment or replacement of management.
General features in the preparation and presentation of financial statements?
1. Fair presentation and compliance with PFRS
2. Going concern
3. Accrual basis
4. Materiality and aggregation
5. Offsetting
6. Frequency of reporting
7. Comparative information
8. Consistency of presentation
Fair presentation and compliance with Philippine Financial Reporting Standards.
The financial statements shall present fairly the financial position, financial performance
and cash flows of an entity.
Virtually, in all circumstances, fair presentation is achieved if the financial statements arc
prepared in accordance with Philippine Financial Reporting Standards which represent
the GAAP in the Philippines.
An entity whose financial statements comply with PFRS shall make an explicit and
unreserved statement of such compliance in the notes.
Fair presentation is defined as faithful representation of the effects of transactions and
other events in accordance with the definitions and recognition criteria for assets,
liabilities, income and expenses laid down in the Conceptual Framework.
Fair presentation requires an entity:
a. To select and apply accounting policies in accordance with PFRS.
b. To present information that provides relevant, reliable, comparable and
understandable information.
c. To provide additional disclosures necessary for the users to understand the
entity's financial statements.
An entity cannot rectify inappropriate accounting policies either by disclosure of the
accounting policies used or by notes or explanatory material.
Preparation of financial statements on a "going concern” basis.
Going concern means that the accounting entity is viewed as continuing in operation
indefinitely in the absence of evidence to the contrary.
Financial statements shall be prepared on a going Concern basis unless management
intends to liquidate the entity or to cease trading or has no realistic option but to do so.
If the financial statements are not prepared on a going concern basis, such fact shall be
disclosed together with the measurement basis and the reason therefor.
Accrual basis of accounting.
An entity shall prepare financial statements, except for cash flow information, using the
accrual basis of accounting.
Under accrual basis, the effects of transactions and other events are recognized when
they occur and not as cash or cash equivalent is received or paid, and these are
recorded and reported in the financial statements of the periods to which they relate.
Simply stated, accrual accounting means that income is recognized when earned
regardless of when received and expense is recognized when incurred regardless of
when paid.
The essence of accrual accounting is the recognition of accounts receivable, accounts
payable, prepaid expenses, accrued expenses, deferred income and accrued income.
Materiality and aggregation
An entity shall present separately each material class of similar items.
An entity shall present separately items of dissimilar nature or function unless they are
immaterial.
Materiality provides that the specific requirements of Philippine Financial Reporting
Standards need not be met if the resulting information is not material.
"Offsetting"
Assets and liabilities, and income and expenses, when material, shall not be offset
against each other.
Offsetting may be done when it is permitted by another PFRS.
For example, gains and losses on disposal of assets are reported by deducting from the
proceeds the carrying amount and the related selling expenses.
Expenditure related to a provision and reimbursed under a contractual arrangement
with a third party may be netted against the related reimbursement.
In addition, gains and losses arising from a group of similar transactions are reported on
a net basis.
For example, foreign exchange gains and losses or unrealized gains and losses arising
from measurement of financial assets at fair value are netted against the other.
The reporting of assets net of valuation allowance is permitted because technically this
is not offsetting.
Thus, accounts receivable may be shown net of allowance for doubtful accounts.
Frequency of reporting
An entity shall present a complete set of financial statements at least annually.
When an entity changes the end of its reporting period and presents financial statements
for a period longer or shorter than one year, an entity shall disclose:
a. The period covered by the financial statements.
b. The reason for using a longer or shorter period.
c. The fact that amounts presented in the financial statements are not entirely
comparable.
Presentation of "comparative information"
Except when a standard or an interpretation permits or requires otherwise, an entity shall
disclose comparative information in respect of the previous period for all amounts
reported in the current period's financial statements.
In other words, the financial statements of the current period shall be presented with
comparative figures of the financial statements of the preceding year.
Comparative information shall also be included for narrative and descriptive information
when it is relevant to an understanding of the current period's financial statements.
For example, details of a legal dispute, the outcome of which was uncertain at the last
reporting date and is yet to be resolved, are disclosed in the current period.
"Third" statement of financial position required
A third statement of financial position is required when an entity:
1. Applies an accounting policy retrospectively.
2. Makes retrospective restatement of items in the financial statements.
3. Reclassifies items in the financial statements.
Under these circumstances, the entity shall present three statements of financial position
as at:
a. The end of the current period
b. The end of the previous period
c. The beginning of the previous comparative period
"Consistency of presentation".
The presentation and classification of financial statement items shall be uniform from one
accounting period to the next.
Any change is allowed when it is required by another standard or when a significant
change in the nature of operations of the entity will demonstrate a more appropriate
revised presentation.
Identification of financial statements.
Financial statements shall be clearly identified and distinguished from other information
in the same published document.
An entity shall clearly identify each financial statement and the notes.
In addition, the following information shall be prominently displayed and repeated when
necessary for the information presented to be understandable:
a. The name of the reporting entity
b. Whether the financial statements cover the individual entity or a group of
entities.
c. The date of the end of the reporting period or the period covered by the
financial statements, whichever is appropriate to the related component of
the financial statements.
d. The presentation currency
e. The level of precision used in the amounts in the financial statements.
STATEMENT OFFINANCIALPOSITION
A statement of financial position is a formal statement showing the three elements
comprising financial position, namely assets, liabilities and equity.
Investors, creditors and other statement users analyze the statement of financial
position to evaluate such factors as liquidity, solvency and the need of the entity for
additional financing.
Asset.
Asset is defined as resource controlled by the entity as a result of past event and from
which future economic benefits are expected to flow to the entity.
The essential characteristics of an asset are:
a. The asset is controlled by the entity.
b. The asset is the result of a past event.
c. The asset provides future economic benefits.
d. The cost of the asset can be measured reliably.
Current Assets
PAS 1, paragraph 66, provides that an entity shall classify an asset as current when:
a. The asset is cash or cash equivalent unless the asset is restricted from being
exchanged or used to settle a liability for at least, twelve months after the
reporting period.
b. The entity holds the primarily for the purpose of trading.
c. The entity expects to realize the asset within twelve months after the
reporting period.
d. The entity expects to realize the asset or intends to sell or consume it within
the entity's normal operating cycle.
Presentation of current assets in the statement of financial position?
Current assets are usually listed in the statement of financial position in the order of
liquidity.
The line items under current assets are:
a. Cash and cash equivalents
b. Financial assets at fair value such as trading securities and other investments in
quoted equity instruments.
c. Trade and other receivables
d. Inventories
e. Prepaid expenses
Noncurrent assets.
The caption "noncurrent assets" is a residual definition.
PAS 1, paragraph 66, simply states that "an entity shall classify all other assets not classified
as current as noncurrent".
Liability
Liability is defined as present obligation of an entity arising from past event, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits.
The essential characteristics of a liability are:
a. The liability is the present obligation of a particular entity.
b. The liability arises from past event.
c. The settlement of the liability requires an outflow of resources embodying
economic benefits.
Current liabilities.
PAS 1, paragraph 69, provides that an entity shall classify a liability as current when:
a. The entity expects to settle the liability within the entity's normal operating
cycle.
b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve months after the reporting
period.
d. The entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period.
Presentation of current liabilities.
PAS 1, paragraph 54, provides that as a minimum, the face of the statement of financial
position shall include the following line items for current liabilities:
a. Trade and other payables
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability
The term "trade and other payables" is a line item for accounts payable, notes payable,
accrued interest on note payable, dividends payable and accrued expenses.
No objection can be raised if the trade accounts and notes payable are separately
presented.
Non-current liabilities?
The term "noncurrent liabilities" is a residual definition.
PAS 1, paragraph 69, provides that all liabilities not classified as current liabilities are
classified as noncurrent liabilities.
Examples of noncurrent liabilities are:
a. Noncurrent portion of long-term debt
b. Finance lease liability
c. Deferred tax liability
d. Long-term obligations to entity officers
e. Long-term deferred revenue
Treatment of a currently maturing long-term debt.
A liability which is due to be settled within twelve months after the reporting period is
classified as current, even if:
a. The original term was for a period longer than twelve months.
b. An agreement to refinance or to reschedule payment on a long-term basis is
completed after the reporting period and before the financial statements are
authorized for issue.
However, if the refinancing on a long-term basis is completed on or before the end of the
reporting period, the refinancing is an adjusting event and therefore the obligation is
classified as noncurrent.
Moreover, if the entity has the discretion to refinance or roll over an obligation for at least
twelve months after the reporting period under an existing loan facility, the obligation is
classified as noncurrent even if it would otherwise be due within a shorter period.
The reason for this treatment is that such obligation is considered to form part of the
entity's long-term refinancing because the entity has the unconditional right under the
existing loan agreement to defer payment for at least twelve months after the end of
the reporting period.
Note that the refinancing or rolling over must be at the discretion of the entity.
Otherwise, if the refinancing or rolling over is not at the discretion of the entity, the
obligation is classified as a current liability.
Covenants
Covenants are often attached to borrowing agreements which represent undertakings
by the borrower.
These covenants are actually restrictions on the borrower as to undertaking further
borrowings, paying dividends, maintaining specified level of working capital and so
forth.
Under these covenants, if certain conditions relating to the borrower's financial situation
are breached, the liability becomes payable on demand.
Effect of breach of covenants on the classification of the liability.
PAS 1, paragraph 74, provides that "the liability is classified as current even if the lender
has agreed, after the reporting period and before the statements are authorized for
issue, not to demand payment as a consequence of the breach".
This liability is classified as current because at reporting date the borrower does not have
an unconditional right to defer Payment for at least twelve months after the reporting
period.
However, Paragraph 75 provides that the liability is classified as noncurrent if the lender
has agreed on or before the end of reporting period to provide a grace period ending
at least twelve months after the end of reporting period.
"Equity"?
Equity is the residual interest in the assets of the entity after deducting all of the liabilities.
Simply stated, equity means “net assets” or total assets minus liabilities.
The terms used in reporting the equity of an entity depending on the form of the
business organization are:
a. Owner’s equity in a proprietorship
b. Partners’ equity in a partnership
c. Stockholders’ equity or shareholders’ equity in a corporation
However, the term equity may simply be used for all business organizations.
Elements of shareholders' equity
Generally, the elements constituting shareholders' equity with their equivalent IAS term
are:
Philippine term IAS term
Capital stock Share capital
Subscribed capital stock Subscribed share capital
Common stock Ordinary share capital
Preferred stock Preference share capital
Additional paid capital Share premium
Retained earnings (deficit) Accumulated profits (losses)
Retained earnings appropriated Appropriation reserve
Revaluation surplus Revaluation reserve
Treasury stock Treasury share
The line items on the face of the statement of financial position, as a minimum.
PAS I, paragraph 54, provides that as a minimum, the face of the statement of financial
position shall include the following:
1. Cash and cash equivalents
2. Financial assets (other than 1, 3 and 6)
3. Trade and other receivables
4. Inventories
5. Property, plant and equipment
6. Investment in associates accounted for by the equity method
7. Intangible assets
8. Investment property
9. Biological assets
10. Total of assets classified as held for sale and assets included in disposal group
classified as held for sale
11. Trade and other payables
12. Current tax liability
13. Deferred tax asset and deferred tax liability
14. Provisions
15. Financial liabilities (other than 11 and 14)
16. Liabilities included in disposal group classified as held for sale
17. Noncontrolling interest
18. Share capital and reserves
The listing of the line items is not exclusive.
PAS 1 simply provides a list of items that are so different in nature and function to warrant
separate presentation on the face of the statement of financial position.
Presentation of assets and liabilities in the statement of financial position.
PAS 1, paragraph 60, provides that an entity shall present current and noncurrent assets,
and current and noncurrent liabilities on the face of the statement of financial position.
Current and noncurrent presentation of assets and liabilities provides useful information
when the entity supplies goods or services within a clearly identifiable operating cycle.
In the Philippines, the common practice is to present in the statement of financial position
current assets before noncurrent assets, current liabilities before noncurrent liabilities, and
equity after liabilities.
Other formats may be equally appropriate provided the distinction is clear. This is in
accordance with paragraph 7 of the Preface to IAS 1.
However, all assets and liabilities are presented broadly in the order of liquidity when
such presentation is reliable and more relevant.
Note that the format of the statement of financial position as illustrated in the appendix
to IAS 1 presents assets, liabilities and equity as follows:
Noncurrent assets
Current assets
Equity
Noncurrent liabilities
Current liabilities
This is the practice in other jurisdiction, like the United Kingdom.
NOTES TO FINANCIAL STATEMENTS
What are notes to financial statements?
Notes to financial statements provide narrative description or disaggregation of items
presented in the financial statements and information about items that do not qualify
for recognition.
Notes contain information in addition to that presented in the statement of financial
position, income statement, statement of comprehensive income, statement of
changes in equity and statement of cash flows.
In other words, notes to financial statements are used to report information that does
not fit into the body of the statements in order to enhance the understandability of the
statements.
Notes to financial statements provide additional information and help clarify the items
presented in the financial statements.
PAS 1, paragraph 113, provides that an entity shall, as far as practicable, present notes
in a systematic manner.
Each item on the face of the statement of financial position, income statement,
statement of comprehensive income, Statement of changes in equity and statement of
cash flows shall be cross-referenced to any related information in the notes.
Purpose of the notes to financial statements?
The purpose of the notes to financial statements is "to provide the necessary disclosures
required by Philippine Financial Reporting Standards."
Specifically, PAS 1, paragraph 112, provides that the notes to the financial statements of
an entity shall:
a. Present information about the basis of preparation of the financial statements and
the specific accounting policies used.
b. Disclose the information required by Philippine Financial Reporting Standards that
is not presented elsewhere in the financial statements.
c. Provide additional information that is not presented on the face of the financial
statements but that is necessary for a fair presentation.
The order of presenting the notes?
PAS 1, paragraph 114, provides that notes are normally presented in the following order:
a. Statement of compliance with PFRS
b. Summary of significant accounting policies used
c. Supporting information or computation for line items presented in the financial
statements
d. Other disclosures, such as contingent liabilities, unrecognized contractual
commitments and nonfinancial disclosures
Note concerning compliance with PFRS.
PAS I, paragraph 16, provides that an entity whose financial statements comply with
Philippine Financial Reporting Standards shall make an explicit and unreserved
statement of such compliance in the notes.
Included in the summary of significant accounting policies
The summary of significant accounting policies shall disclose:
a. The measurement basis used in preparing the financial statements such as historical
cost, current cost, realizable value and present value
b. The accounting policies used
Disclosure of judgments.
PAS 1, paragraph 122, provides that an entity shall disclose in the summary of significant
accounting policies the judgments that management has. made in the process of
applying accounting policies and that have a significant effect on the amounts
recognized in the financial statements.
Disclosure of estimation uncertainty.
PAS 1, paragraph 125, provides that an entity shall disclose information about the
assumptions it makes about the future, and other major sources of uncertainty at the end
of reporting period that have a significant risk of resulting in a material adjustment to the
carrying amount of assets and liabilities within the next financial year.
